A RETIREMENT READINESS REALITY CHECK

Ever since defined contribution (DC) plans supplanted defined benefit (DB) plans as the dominant retirement plan product in the workplace, the choices available to employees for their plan investments have been mostly stocks and bonds, in multifarious packaging, along with some stable value products. Annuities—the cornerstone financial security product of the defined benefit era—are pretty much absent from today’s DC benefits menu.

To be sure, some employee benefit companies, including Prudential and Lincoln National, offer DC plan products that provide guaranteed lifetime withdrawal benefits. The use of these products enables employees to retire with a floor of income they cannot outlive, which research has shown to be one of the key preoccupations of new retirees.

“Consumers place more value on the annuity when they see it as part of a financial plan or strategy.”

–Gary Baker President Cannex USA

With waves of Baby Boomers perched on the threshold of retirement, this would seem to be a good time to probe consumer attitudes about annuities and try to discover if this underutilized investment vehicle might help these soon-to-be retired Boomers make a good transition out of the workplace. Should more employers consider introducing guaranteed lifetime income features into their benefits menu? Or should they at least provide counseling to late-in-career employees about options for individually purchased annuities?

The Retirement Income Industry Association held a webinar in June to discuss the findings of a recent independent study of consumer attitudes toward annuities, both pre-retirees and retirees, commissioned by Cannex USA, a firm specializing in providing comparative information on financial products. Underlying the results were some revealing data about the barriers to annuity purchase from these groups, and what it might take to overcome those barriers. The study also provides some general insights into the retirement planning mindset of today’s workers and new retirees.

Even if benefit plan providers think they have no interest in educating their workforce about annuity options–after all, the subject can be complex—the study results can be useful in learning how pre-retirees and retirees prioritize investment choices. In the fast-changing, complicated world of building retirement security, that’s a good thing.

The study was performed by Greenwald & Associates, a market research firm with a specialization in employee benefits, based on data from just over 1,000 retirees and pre-retirees. This was the first time the study was conducted, and it will be repeated annually, providing comparison data.

Both Gary Baker, president of Cannex, and Dr. Mathew Greenwald, president of Greenwald & Associates, called attention to what they called a “surprising” finding from the participating retirees: Almost half of them (49%) said they expect that during their first 10 years of retirement, their assets (not including their home) will increase. Another 30% thought those assets would stay the same. Only 16% said they expect to have a lower asset level in 10 years.

For those who said they expect their assets to be lower in 10 years (a significantly reduced sample size), 24% thought the reduction would be 1%-10% total (1% per year max), while another 49% thought the total reduction would be 11% to 25%.

The younger the retirees, the more likely they were to believe their assets would increase in the next 10 years (76% at ages 55-59; 55% at 60-64; 47% at 65-69 and 33% at ages 75-79).

“Expecting that assets will not go down is unreasonable,” said Baker. “It implies that people will make lifestyle changes rather than tap the principal (of their retirement funds).” Financial advisors need to understand this sentiment on the part of retirees, he added.

The results show that “people want to be able to retain their assets,” said Greenwald. “Whether they will be able to is questionable, but the results show that this is a goal.”

Perhaps this problematic assumption by consumers has implications for employers. As defined contribution plans have taken over the retirement plan space, employees have gradually become comfortable taking the investment reins into their own hands. Plan sponsors have taught them about advantages of diversification and automatic age-tailored investment guidance. But are employers doing enough to prepare employees for the differences between the asset accumulation phase of pre-retirement and the spend-down phase of post-retirement?

Greenwald pinpointed another way that consumers may be detached from reality as they assess their retirement preparedness. It applies specifically to annuities, but its implications are broader because research has shown that the existence of guaranteed lifetime income products can have a positive effect on investment portfolio performance outside the guaranteed products.

When is an asset not an asset?

“It’s an issue of ‘mental accounting,’” said Greenwald. “People characterize guaranteed lifetime income products in a different way than other assets. It’s almost like they aren’t an asset. When people are asked how much they are worth, they don’t point to Social Security or, in many cases, the equity in their homes. It’s important to communicate that guaranteed lifetime income has a value. It can be calculated, and it should be considered part of their assets and net worth.”

This potentially distorted view of assets is analogous in some ways to what disability income insurers see in the market for their product. Workers need to be made aware that the income stream of their employment is one of their most important, if not the most important, asset they have, and protect it accordingly. Similarly, the purchase of a guaranteed lifetime income stream can provide protection that liberates the buyer to pursue additional investment choices.

The Cannex study indicates that both pre-retirees and retirees are roughly twice as familiar with mutual funds as they are with annuities. However, when consumers were given various cost/return scenarios of annuity products, they were receptive to devoting part of their nest egg to guaranteed lifetime income products–still keeping some of their assets liquid and invested in mutual funds and related products.

The researchers presented the consumers with four potential investment scenarios for a 60-year-old married man with a $500,000 investment portfolio planning to retire at age 65. Three of the options included $100,000 to be invested in different types of annuities, with the balance going to stocks and bonds. The fourth was to be invested entirely in stock and bond mutual funds. The scores for all the options that included the annuities (ranking them as either “very good idea” or “good idea”) all exceeded the score for the choice of stocks and bonds only.

When asked to rate the importance of guaranteed lifetime income to supplement Social Security, 43% said “extremely valuable,” and another 30% said “valuable.” “They place more value on the annuity when they see it as part of a financial plan or strategy,” said Baker. “That points to the value of a process sale, rather than a product sale.”

The study showed that the demographic groups that are most attracted to purchasing an annuity as a strategy for income are women, younger consumers (ages 55-59) and those with $250,000 to $1 million in assets.

There is a lot more data to ponder in the study. The overriding question hanging over the results is whether guaranteed lifetime income products need to play a bigger role in helping workers achieve a secure retirement.